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Financing Mix

Company A is equity financed with 10000 shares of equity outstanding selling for $100 a share. It is restructuring. Low debt plan is to issue debt of $200,000 with proceeds to buy the stock. The high debt lan would exchange $400,000 of debt for equity. The debt will pay an interest rate of 10%. Company A pays no taxes.

a What is the debt to equity ratio after each restructuring?

b. If EBIT is either $90,000 or $130,00 what is the earning per share for each financing mix for both possible value of EBIT?

c) Suppose EBIT is $100,000 what is EPS under each financing mix?

d. Why is it the same in this case?

Please show the calculations.

Solution Preview

a What is the debt to equity ratio after each restructuring?

The total equity existing is 10,000 shares at $100 each = $1,000,000. When debt is issued, the equivalent amount of equity is repurchased. At 200,000 of debt, equity will be reduced by 200,000 and will be 800,000. Debt/Equity = 200,000/800,000 = 0.25. ...

Solution Summary

The solution explains how the calculate the impact of changes in financing mix.

$2.19